Morgan Stanley sees $100 billion issuance in 2002, 8%-10% returns

By Paul A. Harris

St. Louis, Mo., Jan. 14 - Citing a favorable interest rate environment, sizable cash positions in high yield mutual funds, and a large amount of private equity on the sidelines, Morgan Stanley forecasts $100 billion of high yield new issuance in 2002, and returns of 8%-10%.

"The one factor that could possibly move the needle to the downside is the cable sector," commented Matt DeFusco, vice president of Morgan Stanley High Yield Syndicate. "And the cable space could not be in any stronger form, fundamentally.

"Cable has really killed all comers, on a competitive basis. The DSL-guys are no longer a threat. And I really believe that the recent Comcast-AT&T trade, at $4,500 a sub, confirms the market's view of the asset value coverage.

"That is one of the reasons why we're fairly sanguine on the returns this year."

DeFusco penned a report, "2001 High Yield Market Review & 2002 Outlook," and hosted a Monday teleconference.

The Morgan Stanley forecast factors in an excellent interest rate environment, estimated cash positions of 10% on the part of the high yield mutual funds, a pick-up in corporate M&A volumes, the return of financial sponsors and continued refinancing of bank debt.

And factoring in potential "supply" from fallen angels downgraded, DeFusco said that the market could see $150 billion of bonds coming onto the market in 2002.

DeFusco notes that Morgan Stanley economists estimate that the 10-year Treasury note over the next two years will yield between 4.5%-5.25 %.

"Those are some of the lowest levels we've seen in the past decade," he commented, adding that the low Treasury yield creates an excellent environment for high yield new issuance.

While sponsor-related high yield issuance totaled only $4.67 billion in 2001, DeFusco said that Morgan Stanley believes the stage is set for considerably more to come, in 2002.

According to the most recent figures, he said, at the end of 2000 the top 71 financial sponsors were sitting on $150 billion of uninvested funds. A stabilizing 2002 economy would thus suggest a pick-up in leveraged buyout activity, he added, while a volatile economy would result in sponsors turning to PIPEs - Private Investments in Public Equities.

"To the extent that the economy doesn't begin to stabilize, and you have a handful of top-tier, publicly-traded companies that may be looking for a war chest to grow in this depressed environment, you may see the financial sponsors step up and give $200 million, $300 million, or $400 million to an existing high yield issuer, to prosecute an M&A strategy," DeFusco said.

"This is actually good news for the high yield market because it provides an underpinning, if you will, for existing trading levels, considering that it's going to be a large slug of equity that is going to come in to support bond levels in 2002 - to the extent that new issuance doesn't take place," he added.

He pointed to the Comcast-AT&T trade, and said that it stands as a good harbinger of M&A-activity in 2002.

DeFusco points to "the class of 1997's" bonds, and states that approximately $58 billion of paper will become callable in 2002. Considering that the average yield on the 10-year Treasury in 1997 was roughly 135 basis points higher than today, he adds, tender-refinance and call-refinance transactions will pick up considerably this year.

Issuers began to tap the market actively at the end of 2001, DeFusco said, identifying A&P, Gray Communications, Sinclair Broadcasting, ISP Chemco and KB Home.

End

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